Proposal: Bigger Down Payments on FHA Loans Above $625,500

The Federal Housing Administration is still reeling from financial losses resulting from the housing crisis. As a result, the agency is looking for ways to reduce risks and shore up its capital reserves. In support of these goals, the Department of Housing and Urban Development (HUD) has announced a series of changes to the FHA loan program.

The latest rule change has to do with down payments on FHA loans larger than $625,500. Specifically, HUD has proposed raising the minimum down payment for government-insured loans over $625,500 from 3.5% (the previous standard for all FHA loans) to 5%.

Stated differently, the maximum loan-to-value (LTV) ratio for these larger loans would fall to 95%, compared to 96.5% previously. This is the latest in a series of steps designed to minimize risks and increase revenue.

5% Down Payment for Larger Loans

According to the Federal Register notice:

“This notice proposes to set a 95 percent maximum LTV for FHA-insured loans over $625,500, with certain exemptions … HUD has determined that this proposed change to the LTV requirements is necessary to improve the health of the MMIF [Mutual Mortgage Insurance Fund]…”

There was no explanation on what ‘exemptions’ would be allowed.

The comment period for this proposal ended earlier this month. This is typically the first step in a process that ultimately leads to a permanent rule change. Barring any major outcry from lenders and housing advocates, we expect this rule to be passed.

3.5% for All Other FHA Loans

The minimum down payment on FHA loans equal to or less than $625,500 would remain unchanged at 3.5%. This is the primary appeal of the FHA program. Home buyers who lack significant cash reserves often use government-insured mortgage loans to minimize their down payment expense.

Most conventional loans these days require at least 5% down, and sometimes as much as 10%. High-risk borrowers with financial troubles in their past are often required to put down as much as 20%. So the FHA program frequently becomes a last resort for borrowers who lack down payment funds.

A Series of Program Changes

HUD has implemented a number of additional rules in 2012 and 2013. For instance, they have increased the mortgage insurance premiums (MIP) borrowers must pay when using an FHA loan. They have also implemented some new rules regarding credit scores and debt ratios.

These are not the first changes to the program, and they probably won’t be the last. The 5% down payment requirement for FHA loans above $625,500 is indicative of a larger problem within the Federal housing Administration. This federal agency is required to maintain capital reserves equal to 2% of its total loan guarantees. But insurance payouts stemming from the housing crisis have obliterated the agency’s capital reserves. In fact, an audit last year found the FHA to be deep into negative territory.

There have been rumors that HUD is also planning to raise the minimum down payment or smaller FHA loans. But as of right now, these are merely rumors. At this time, we see no indication of a minimum 5% down payment across the board. The current proposal specifically applies to FHA loans larger than $625,500.

Harder to Qualify for FHA

The down payment is only one obstacle to FHA financing. In most cases, borrowers will also need credit scores of 600 or higher and debt-to-income ratios below 45%.

Additionally, new rules for 2013 state that borrowers with credit scores below 620 and total debt-to-income ratios above 43% must undergo a more rigorous form of underwriting. Instead of being approved through the FHA’s automated underwriting system (known as TOTAL Scorecard), these borrowers must be reviewed by a human underwriter.

FHA borrowers must also have sufficient funds in the bank to cover their closing costs. Mortgage lenders typically verify the borrower’s financial assets at the time of application, to ensure they can cover both the down payment and the closing costs.

Note: We will update this story if and when the new down payment rule comes to fruition.

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